The Many Effects of Inequality

By Carolyn Burstein

October 15, 2014

Although there have been several blogs on this website on the topic of inequality, the issue is increasingly relevant for so many reasons, not the least of which is the fact that inequality is the source of so many economic ills. Wherever one looks the specter of inequality rears its head.

In my recent blog on the Census Bureau’s poverty data, I referred to a recent article in the Washington Post about the effects of the wealth gap on the inability of young people to purchase their first home. I referred as well to a recent study by Standard and Poor’s describing how states were experiencing a decrease in normal revenue from sales taxes due to wage stagnation and a lack of demand among the majority of their populations. Earlier I had written a blog about the use of “dark money” in political campaigns, thanks to the Supreme Court decisions (Citizens United v. FEC and McCutcheon v. FEC), which give the wealthy an outsize influence in elections. And the list goes on.

Let’s consider some of the effects of inequality on economic growth, various social issues, global trade, higher education, and even the Scottish vote. Naturally, the results of inequality are even more far-reaching (and damaging), than this disparate list suggests, but we will scrutinize these for starters. But first, let’s focus on a few issues related to inequality. Did you know that regressive payroll taxes, which cost people in poverty proportionately much more than the wealthy, are projected to raise about one-third of federal revenue in 2015? Or that the U.S. ranks highest among the high-income countries (according to a study by the Organization for Economic Cooperation and Development – OECD) in its share of relatively low-paying jobs? These are just two fascinating details in an October 1, 2014 article in the Financial Times by Martin Wolf, economics editor of the paper.

So, how much wealth do these rich people have? A very similar question has recently (mid-September 2014) been put to people in various countries. They were asked in a poll how much money top executives of major companies make relative to the average workers in their firms, and in the U.S. the median respondent believed it was about 30 times more. Unfortunately, chief executives earn more than 300 times as much as ordinary workers, an amount vastly underestimated by nearly all Americans and reflecting the concentration of wealth at the top of the financial pyramid. This situation is what Thomas Piketty in his bestselling Capital calls the super salaries of “supermanagers”.

Celebrities and sports/movie stars earn far less than many of the financial barons who dominate the upper strata of the wealthy. In 2013 the top 25 hedge fund managers received, on average, almost a billion dollars each, according to Paul Krugman. Ignorance about this problem may be one reason why income inequality hasn’t yet become a dominant issue in elections!

Data from Thomas Piketty and Emmanuel Saez, the academics who have made a specialty in documenting the rise of income inequality around the world, shows that during the first three years of the recovery from the Great Recession (2009-12), the top 1% of the population, took home 95% of the income gains, while incomes actually fell for the bottom 90%. Until the recessions of the 1970s, most income gains experienced during subsequent expansions accrued to most of the people, but with each expansion since that time, the bottom 90% captured a smaller and smaller part of income. Family net worth, a measure of accumulated wealth, showed a similar skewing upward.

Some say that the Federal Reserve’s policies of zero interest rates and quantitative easing (buying bonds with newly-printed money) are inadvertently responsible for the income inequality the nation is currently experiencing. Certainly, inequality could have been worse without these policies, since they helped to prevent massive joblessness in 2008-09. But there is no doubt that extremely low interest rates hurt small savers who were not able to diversify into higher-yielding investments. And Wall Street enjoyed the Fed’s “easy credit” and the profits of the bull market. Many couldn’t help noticing that years of an ultra-loose monetary policy might risk skewing the U.S. income distribution upward. However, most of the evidence for income inequality indicates that its rise started many decades before and its causation is multiple, not least of which is the fact that tax and spending policies are much less redistributive than they were even a few decades ago.

It’s time to consider the effects of inequality on the various issues raised above. First, let’s look at inequality’s effects on economic growth. At an IMF seminar in mid-April 2014 there was a clear conviction that economic growth and inequality were mutually incompatible. The participants welcomed the growing consensus around the world on the need to address inequality and the IMF’s role in this process. The Deputy Managing Director of the IMF clarified that their advice to countries now always includes jobs, growth and employment in policy formation.

There is a strong belief that inequality today has reached levels that threaten economic stability and growth. As Joseph Stiglitz, the Nobel Prize-winning economist, has written in The Price of Inequality, “Widely unequal societies do not function efficiently, and their economies are neither stable nor sustainable in the long term. Taken to its extreme – and this is where we are now – this trend distorts a country and its economy as much as the quick and easy revenues of the extractive industry distort oil-or mineral-rich countries.”

In the U.S., the Great Recession illustrates how an excess of inequality can warp an economy. The housing boom crisis showed that a strong segment of the public was unwilling to accept their depressed spending power, and encouraged by those who, often illegally, eased credit standards, were able to sustain their purchasing power by borrowing using flimsy home mortgages. Marianne Bertrand and Adair Morse of the University of Chicago have found that legislators who represent constituencies with higher inequality are more likely to support the easing of credit. And credit splurges, they find, bring on instability in the financial sphere. The economy, propped up on shaky credit, becomes more vulnerable to shocks, so that when a recession comes, the economy virtually collapses as banks fail and consumer spending drops.

Income inequality also exerts a significant drag on demand, as people with low-incomes have been forced through credit contraction to spend less. This situation acts as a vicious circle, since business investment is curbed by weak growth in demand for products and services. Many companies have been encouraged to replace unskilled labor with machines, contributing further to downward wage pressure. It is this wage stagnation that is a major contributor to today’s weak recovery. So, income inequality comes full circle. The global trends are stark. Stefano Scarpetta, director for employment, labor and social affairs at the OECD, says’ almost all advanced economies have seen labor’s share of gross domestic product fall over the past 20 years.”

Income inequality causes a range of social problems by undermining social cohesion and increasing social divisions and placing greater importance on social hierarchy, status and class. Distinctions between rich and poor neighborhoods become paramount. Social relationships are severed and trust is lost. Indicators of women’s status are generally better in more equal societies. Rates of both property crimes and violence increase as income differences widen. Inequality drives status competition, which drives personal debt and consumerism, and the latter is a major threat to sustainability. Stronger community life in more equal societies also means that people are more willing to act for the common good – they recycle more, spend more on foreign aid, and focus more on peace. Business leaders in more equal countries rate international environmental agreements more highly. The social fabric of society allows populations to either flourish or fail.

What has been the impact of our global trade efforts on income inequality? Our trade agreements of the past 20 years have led to a massive decrease in tariffs from over 40% in the 1950s to less than 3% on most industrial goods today, and other barriers to trade have been radically reduced, with the result that prices for these goods over the past 10 or 20 years have been drastically reduced. But it is well to keep in mind that the U.S. comparative advantage is in capital and technology and our disadvantage is in labor, particularly unskilled labor. Thus, our lower-income people are competing with those whose wages are significantly depressed by American standards.

A recent study by the U.S. International Trade Commission has concluded that global trade in general has contributed to 10 to 20% of the wage gap between more skilled and less skilled workers, certainly not a majority of the difference, but a significant slice of it. In negotiating a free trade agreement with some developing countries, such as Vietnam and Malaysia, in the Trans-Pacific Partnership (TPP), the U.S. should bear in mind that a number of Asian countries have suppressed the value of their currencies (currency manipulation), which has severely hurt our economy and depressed the wages of U.S. workers. The TPP must address issues like currency manipulation so that income inequality does not become greater than it already is.

Also, the study points out that the U.S. needs a robust Trade Adjustment Assistance (TAA) program to provide funds to help workers who have been laid off to get the training and education they need to launch a new career and get unemployment benefits during their transition. The current TAA is considered worthless by many of the workers it has been intended to help because it either fails to provide the unemployment compensation for the jobs they have lost or fails to provide them with adequate training and skill levels needed to enable them to acquire jobs in new areas. The 113th Congress has not taken any action on this issue.

Although not the only concern of many Democrats regarding global trade – issues like labor rights, environmental protection and patents are others – income inequality is central for many. For example, Robert Reich writes: “This massive deal [TPP] would further erode the jobs and wages of working and middle-class Americans while delivering its biggest gains to corporate executives and shareholders.” Harold Meyerson, writing in the Washington Post earlier this year agrees with Reich but also notes that the U.S. trade deficit with Canada and Mexico rose from $27 billion in 1993 to $181 billion in 2012. Meyerson writes, “when the case for free trade is coupled with the case for raising workers’ incomes, it enters a zone where real numbers, and real American lives, matter…Such deals [referring to the TPP] increase the incomes of Americans investing abroad even as they diminish the incomes of Americans working at home.”

A Huffington Post article earlier this year noted that the Peterson Institute for International Economies – a strong supporter of global free trade – estimated that nearly 40% of the observed growth in U.S. labor inequality was attributable to trade trends. It isn’t difficult to understand why after calculating the employment effects of trade flows using the government’s own methodology for translating the U.S./Canada-Mexico trade deficit figures for 2012. This trade agreement alone has been responsible for the American loss of one million jobs and doesn’t include the loss of jobs associated with the U.S.-South Korea Free Trade Agreement, which have been substantial.

The Huffington Post article warned that one should not necessarily focus only on the number of jobs lost, but on their composition. The millions of workers who had belonged to the middle class but did not have a college degree were competing for non-offshorable, low-skill jobs in sectors such as food service and retail, where wage stagnation had already occurred, due in part, to the excess supply of laborers. According to the U.S. Bureau of Labor Statistics, two of every three displaced manufacturing workers who were rehired experienced a wage reduction, most of them more than 20%. Is it any wonder that Democrats in Congress are reluctant to grant the president “Fast Track Authority” which would enable trade agreements similar to those negotiated in the past 20 years, to be voted up or down in Congress without changes?

So, what are the chances of higher education coming to the rescue of income inequality? If, as Alan Blinder (former Federal Reserve vice-chair, Princeton economist and NAFTA supporter) says, one out of every four American jobs could be offshored in the foreseeable future, then, it would seem, young, disadvantaged “millennials” must overcome barriers to a first-rate higher education. In a September 21, 2014 article in the New York Times, Vicki Madden, a former high school teacher, lamented the social isolation and alienation that most of the bottom 50% of Americans experience in the 200+ “top-tier” colleges across the country. Colleges now are more divided by wealth than ever, she writes. Many of these kids struggle academically and do not feel comfortable asking their professors for help or feel welcome in student study groups. These are among the prime reasons so many drop out.

In a recent paper, Anthony Carnavale and Jeff Strohl found that at 193 rather selective colleges, only 14% of students were from the bottom 50% of Americans in terms of socioeconomic status. And Martin Wolf, in his October 1, 2014 article in the Financial Times (referred to above) quotes a Standard and Poor’s report that for the poorest households college graduation rates increased by only about 4 percentage points between the generation born in the early 1960s and the early 1980s. The graduation rates for the wealthiest households increased by about 20 percentage points over the same period. Yet without a college degree, the chances of upward mobility remain dim. One can only hope that those born since the early 1980s fare better than their older brothers and sisters.

What in the world does the Scottish Vote for independence have to do with American income inequality? We Americans probably paid little heed to that all-important UK vote on September 18, 2014. This was the same week that the U.S. Census Bureau released data on U.S. poverty which divulged that so-called middle-income Americans made eight % less in 2013 than they did in 2007. What these facts have in common is that many millions of people in both Scotland and America (and many other countries, too) no longer trust their more wealthy governing bodies.

The Scots have little in common with our “Tea Party.” They are more left-wing than the majority in the British parliament and its ruling party, desire more social welfare spending rather than austerity, want greater efforts in the environmental area and oppose the British parliament’s emphasis on defense. Millions of Scots proved that their tolerance for their governing institutions had badly diminished. And London has heard the results of the vote (closer than many believed possible) and promised reform, although specifics were in short supply.

The U.S. poverty data are bleak and make clear that a middle-class American family is worse off financially today than it was 15 years ago. The fact that the system isn’t working for most American workers pervades public opinion polling as well as mid-term election results for the past few years. The causes are multiple, as the foregoing indicates. The issue in this country is whether tolerance of the current system will continue or what direction the opposition to it will take.

If the ability to tolerate our economic system wanes, we, at NETWORK, oppose the tools of violent conflict. We strongly believe in the power of the ballot box and legislation to right grievances. Because we are a government of, by and for the people, we believe that people with a comprehensive vision, compassion, and real leadership qualities will run for office, be strongly supported by those who oppose the status quo and, if elected, will serve the common good by supporting all Americans, including especially poor and vulnerable families. Often this will mean supporting policies that require uncommon courage to change the status quo in ways that are innovative but desirable for those who have borne the scourge of injustice. All government leaders have a shared duty to all segments of society, but especially to ensure that no one is left behind. And that means that today’s level of income inequality requires a sizable level of moderation.